Current Issues : TAX IS NOT VIRTUAL

Chong Mun Yew

8 TAX GUGUARDIANARDIAN - AAPRILPRI L 20182018 cryptocurrency: tax is not virtual

parties are kept private. are stored in a wallet. The Bitcoin wallet is basically just a collection of Bitcoin addresses. Each of the Bitcoin addresses was IN AN ONLINE REPORT BY FINANCIAL TIMES , created with a valid private key. “COINCHECK PROMISES REFUND AFTER USD500M Bitcoin has the characteristic of a Fiat currency which CRYPTOCURRENCY HEIST” ON 28 JANUARY 2018, means that it is not backed by a physical commodity like < A JAPANESE CRYPTOCURRENCY EXCHANGE gold or government guarantees. Currently, most nations ISSUED AN APOLOGY AFTER HACKER STOLE utilise fiat currency to drive their economies. The biggest CRYPTOCURRENCY1 BELONGING TO 260,000 fiat currency would be the United States Dollar which has CUSTOMERS. JAPANESE CRYPTOCURRENCY been a fiat currency since 1971 .8 The thing that gives a fiat EXCHANGE COINCHECK SAID IT WOULD currency value is its scarcity, guarantee of value from the REPAY CUSTOMERS AFTER FALLING VICTIM TO issuing state and the laws of supply and demand. ONE OF THE WORLD’S BIGGEST HEISTS 2. For example, assuming the supply and demand of Bitcoin remains stable but the community was to lose faith in the value of Bitcoin, the community would then start to sell their Bitcoin bringing down the price of Bitcoin due to Given the size of the heist and the fact that it was oversupply of Bitcoin in the market. committed digitally, this is worrying especially in today’s digital age! We are all familiar with the saying: There are WHAT CAN BITCOIN BE USED FOR? only two things certain in life i.e. death and taxes 3, but can Bitcoin can be spent just like any conventional cryptocurrency escape taxes? Cryptocurrency creates many currency at any merchants that accept it. It can also be new headaches for regulators in respect of the legality and sold to people who wish to purchase Bitcoin for whatever taxation of this new asset class. purpose. This article seeks to examine the premise of Bitcoin 4, the very first widely accepted and its HOW CAN YOU OWN BITCOIN? potential effect on the taxation industry. There are two ways in which you can own Bitcoin, the easiest way is to purchase it at one of the many new THE RISE OF DIGITAL CURRENCY cryptocurrency exchanges. This is also the more expensive Prior to 2009, no one seriously foresaw the rise of option considering the price of a Bitcoin as at 2 March digital currency. After the financial crisis highlighted the 2018 is almost USD10,980. 9 oversight by the central banks and financial institutions The alternative is to mine Bitcoin. Mining Bitcoin which lead to losses in monetary reserves, people start involves adding Bitcoin transaction data to the Bitcoin’s looking for a more secure replacement to traditional global public of past transactions. Each group fractional reserve banking. of transactions is called a block. Blocks are secured by On 3 January 2009, Bitcoin, the very first decentralised Bitcoin miners and built on top of each other to form the digital currency utilising the 5, was launched blockchain. The blockchain confirms the transactions by a mysterious person known only by the pseudonym as having taken place to the rest of the network. Bitcoin , whose true identity remains nodes running the Bitcoin programme use the blockchain unknown 6. Since then, the value of Bitcoin has steadily to distinguish legitimate Bitcoin transactions from those appreciated as the demand for the digital currency grew transactions that attempt to re-spend coins that have despite a few small dips in its short 10 year history. 7 At the same time, the increase in the demand for digital 1 Wikipedia, Cryptocurrency, on 12 April 2013, currencies has spawned more new like https://en.wikipedia.org/wiki/Cryptocurrency. and Ripple. With the introduction of more new 2 Financial Times, Coincheck promises refund aer $500m cryptocurrencies, it increases the market capitalisation of cryptocurrency heist, on 28 January 2018 https://www..com/ digital currency. content/7b0d7660-03ea-11e8-9650-9c0ad2d7c5b5. 3 Benjamin Franklin, in a letter to Jean-Baptiste Leroy, 1789 stated WHAT IS BITCOIN? “Our new Constitution is now established, and has an appearance Bitcoin is a decentralised digital currency where that promises permanency; but in this world nothing can be said to be Bitcoins are registered with a Bitcoin address. This makes certain, except death and taxes.” the entire system pseudonymous with transactions being 4 Wikipedia, Bitcoin, on 12 April 2013, https://en.wikipedia.org/wiki/ recorded under pseudonyms so that the identities of the Bitcoin.

TAX GUARDIAN - APRILAPRI L 2018 9 cryptocurrency: tax is not virtual

already been spent elsewhere. reaches a hash rate . Profits derived by Bitcoin mining is getting more of 20 Th/s, it means that the network businesses which mine and trade expensive as more and more can make 20 trillion calculations per virtual currencies in exchange for processing power is required to second. 11 money are also subject to tax. compute the hash functions required However, like Malaysia, there is to secure a block to the blockchain. IS CRYPTOCURRENCY THE NEXT TAX no capital gains tax in Singapore. This has led to many Bitcoin mining FRONTIER? Hence, long-term investment in pools being set up to share in the Different jurisdictions across Bitcoin would not be subjected to costs of mining Bitcoin. This is akin the world have taken a different tax. 13 to a joint venture with many miners approach in respect of the taxation of from all over the world to contribute cryptocurrency. We will examine a EUROPE to a . few of the approaches below. In Europe, there is no consensus on whether Bitcoin is a currency. HOW DO YOU MINE BITCOIN? UNITED STATES However, the European Court To mine Bitcoins, miners must The United States Inland Revenue of Justice has held that Bitcoin find a hash value that includes a list Service classifies virtual currency as exchanges should be exempted from of all of the most recent transactions Value Added Tax (VAT) on the basis that need to be verified. Once a that the only purpose of Bitcoin is miner finds such a value, he or she as a means of payment, the court broadcasts it to the Bitcoin network. concluded that the ‘currency’ The set of transactions are now exemption in Skatteverket v David verified, and that set becomes the Hedqvist Case C-264/14 should next block in the Bitcoin apply. blockchain. The miners then receive their reward WHAT IS THE for contributing their MALAYSIAN computational power STANCE ON to operate the Bitcoin BITCOIN? protocol. 10 The hash Malaysia’s rate is the number of Finance Minister times a hash function II, Datuk Seri Johari can be computed per Abdul Ghani said in a second. The Bitcoin recent interview with the miner’s expected profit Malaysian Reserve that Bank is directly proportional to Negara will not impose a blanket the hash rate of his Bitcoin mining ban on cryptocurrencies as such machines. action will only curb innovation and Bitcoin mining is intentionally creativity in the financial sector, designed to be resource-intensive particularly in financial technology. 14 and difficult, so that the number of property for United States Federal On 9 January 2018, a land deal blocks found each day by miners tax purposes. 12 Therefore, capital was sealed using Bitcoin in Sabah remains steady over time, producing gains taxes are applicable for gains between Alexander Yee and Polycarp a controlled finite monetary supply. on the value of virtual currency in Chin. The land was still subject to The amount of computing power the United States. the Real Property Gains Tax. On 27 required to mine Bitcoin depends February 2018, Bank Negara issued on the Bitcoin network’s hash rate SINGAPORE a policy document on Anti-Money which is the measurement unit of In Singapore, the Inland Revenue Laundering and Counter Financing the processing power of the Bitcoin Authority of Singapore has held that of Terrorism (AML/CFT) of Digital network. The Bitcoin network must businesses that buy and sell virtual Currencies. 15 In the policy document, make intensive mathematical and currencies in the ordinary course of Bank Negara reiterates its stance that cryptography related operations for their business will be taxed on the digital currencies are not legal tender security purposes. For example, if the profits derived from trading in the in Malaysia. The policy paper sets

10 TAX GUARDIAN - APRIL 2018 cryptocurrency: tax is not virtual

out new reporting requirements for a There are a few arguments that illegal trades are subject to tax. In person who provides cryptocurrency taxpayers can argue against the this regard, the non-regulation of exchange services such as the imposition of tax on their gains cryptocurrency does not prevent exchange digital currency for money from cryptocurrency. A few of these the profits from such businesses or vice versa regardless of whether arguments will be discussed below. they have a physical presence in 1. Foreign source income 5 Wikipedia, Blockchain, on 12 April 2013, Malaysia. Taxpayers can argue that https://en.wikipedia.org/wiki/Blockchain. the income gained from the A blockchain, originally block chain, is a IS CRYPTOCURRENCY SUBJECT TO cryptocurrency transaction is continuously growing list of records, called MALAYSIAN INCOME TAX? 17 foreign sourced income and blocks, which are linked and secured using Currently, the Inland Revenue not subject to tax, being derived cryptography. Each block typically contains Board Malaysia (IRBM) has yet from outside of Malaysia. a cryptographic hash of the previous block, to issue definitive guidelines on This argument will likely be a timestamp and transaction data. By how to subject the cryptocurrency challenged by the IRBM as the design, a blockchain is inherently resistant transactions to tax. However, on 19 taxpayer would be unable to to modi!cation of the data. It is “an January 2018, the chief executive prove that the transaction came open, that can record officer Dato’ Sri Sabin Samitah from overseas. transactions between two parties e"ciently said that even if cryptocurrency As discussed, the nature of and in a veri!able and permanent way”. businesses are not regulated in Bitcoin transaction is that the For use as a distributed ledger, a blockchain Malaysia, the businesses are still address of the receiver and the is typically managed by a peer-to-peer subject to Malaysian income tax sender are masked. The taxpayer network collectively adhering to a protocol pursuant to Section 3 of the Income would have a hard time proving for validating new blocks. Once recorded, Tax Act 1967 (ITA), where tax shall that the transaction took place the data in any given block cannot be altered be charged upon the income any overseas without revealing the retroactively without the alteration of all person accruing in or derived from identity of the sender or the subsequent blocks, which requires collusion 16 Malaysia. He said that the current receiver. of the network majority. provisions of the ITA are applicable 2. Legality of cryptocurrency 6 #e Economist explains, How Does Bitcoin to all cryptocurrency traders. business Work?, on 12 April 2013, https://www. He further added that the Although the cryptocurrency economist.com/bitcoinexplained. cryptocurrency company would need business is not regulated in 7 Buy Bitcoin Worldwide, Bitcoin Price to keep proper books of accounting Malaysia, in the tax case of History Chart, on 2 March 2018, https:// and business records in Malaysia for Lindsay, Woodward and Hiscox www.buybitcoinworldwide.com/price. the purpose of being audited by the v IR Commrs (1932) 18 TC 43, it 8 American Monetary Association, How relevant law enforcement agencies. was held that profits made from American became a !at currency, 2 March 2018, http://americanmonetaryassociation. org/how-the-us-dollar-came-to-be-a-!at- currency/. 9 Coindesk, Bitcoin (USD) Price, 2 March 2018, https://www.coindesk.com/price. 10 Quora, What does Bitcoin hash rate mean?, 2 March 2018, https://www.quora.com/ What-does-Bitcoin-hash-rate-mean. 11 Bitcoin, What is Bitcoin mining, 2 March 2018, https://www.bitcoin.com/bitcoin- mining. I2 Inland Revenue Service, IRS Virtual Currency Guidance : Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, on 2 March 2018, https://www.irs.gov/newsroom/irs-virtual- currency-guidance.

TAX GUARDIAN - APRIL 2018 11 cryptocurrency: tax is not virtual

from being taxed. that the identity of the person ledger will have records on the 3. Tax Residency making those gains may not be transacted prices and time of The taxpayer can move around who it seems. Of course, bringing transfer. The taxpayers have the world to avoid being the money back for utilisation is a to subtract the cost of the classified as a tax resident in different issue altogether. cryptocurrencies against the Malaysia. Given the global nature 4. Income from hobby or from selling price to determine the of the cryptocurrency in general, investment gain or loss. In this regard, the and Bitcoin in particular, these The taxpayers can argue that they taxpayers must keep track of Malaysian taxpayers can sell bought cryptocurrency merely their cryptocurrency transactions their Bitcoins from anywhere as a hobby or as a long-term continuously to report the gain without the hefty cross border investment. or loss on each cryptocurrency transaction fees. These taxpayers However, if a business arises as transaction properly. could run the argument that they a by-product of a hobby or other The application of the 40 year are not tax residents of Malaysia non-commercial activities, its old principles of the badges of and therefore are not subject to profits could also be subjected to trade from NYF Realty Sdn. Bhd.

Malaysian income tax. However, tax. v Controller of Inland Revenue to note on the recent case of Hii This is seen in the tax case of could still be applicable in Yii Ann v Deputy Commissioner Hawes v Gardiner (37 TC 671) determining whether there is an of Taxation of the Commonwealth where a taxpayer bred and intention to trade: of Australia & Others where a trained dogs as his hobby. The (1) Subject matter of the transaction taxpayer claimed that he was not General Commissioners found Unlike enterprises, Bitcoin has no a tax resident of Australia and that the selling of puppies for business, no intrinsic value, no the Australian Tax Office should substantial prices by the taxpayer cash flows and no balance sheet. not be able to extend its taxation was in the nature of trade and It is a speculative instrument 18 hand overseas to tax a Malaysian subjected the profits from the sale and which is normally the subject taxpayer. Unfortunately, the of puppies to tax. of investment. taxpayer lost the case at this In the current circumstances, the This is seen in the tax case of Dr. juncture. trading of cryptocurrency may Zanariah Binti Ramli v Ketua The other issue to consider is be subjected to tax. The taxable Pengarah Hasil Dalam Negeri, who is actually making profits. transactions occur every time where the Court of Appeal held In the age of Virtual Private the cryptocurrency is traded in that the gains made from the Networks it would be possible virtual exchanges. The blockchain bond market is subject to income

12 TAX GUARDIAN - APRIL 2018 cryptocurrency: tax is not virtual

tax based on the grounds that the since 2009, he could argue that (4) Alteration of property to render appellant had in fact been actively he is a long-term investor for the it more saleable trading in bonds during the currency. However, for all recent Due to the nature of period. transactions, it would likely be cryptocurrency, the taxpayer is Numerous or repetitive acts done considered an adventure in the unlikely to be able to alter the by the appellant would suggest nature of a trade and be subjected cryptocurrency to make it more the action was in the nature of a to tax. saleable. trade. (3) Frequency of transactions (5) Methods employed in disposing In view of the above, holding #is is the easiest way to identify of property cryptocurrency would likely have speculators of cryptocurrency. If special exertion was made to the characteristic of an asset held #ere will be multiple find or attract purchasers for for trading in the eyes of the cryptocurrency transactions to the cryptocurrency, it might IRBM. and from the same address or indicate an intention to sell (2) Period of ownership wallet within a short period of it for profit. However, in the The period of ownership of the time. All Bitcoin transactions are current circumstances, it is cryptocurrency can be controlled public, traceable and stored in the easy for the taxpayer to buy by the taxpayer. The benefit Bitcoin network. In the present and sell cryptocurrency with of holding cryptocurrency case, if the IRBM is able to look the cryptocurrency exchanges. is that there are no holding behind the Bitcoin pseudonyms Further, cryptocurrency is costs unless the taxpayer has and identify the owner of the currently a very liquid asset borrowed money to purchase , the IRBM that can be spent on goods and this cryptocurrency. Arguably can further investigate the owner of services just like conventional if a taxpayer has held Bitcoin cryptocurrency and tax accordingly. currency. Arguably, this badge cryptocurrency: tax is not virtual

currency powered by blockchain technology is the question on every government regulator’s mind. It is clear that the tax laws have to play catch up or potentially lose out on a digital gold mine of tax revenue.

Disclaimer: #is article does not seek to address all tax issues associated with cryptocurrency and all views expressed are purely the personal opinion of the author.

13 Inland Revenue Authority of Singapore, Income Tax Treatment of Virtual Currencies, on 2 March 2018, https://www. iras.gov.sg/irashome/Businesses/Companies/ of trade may not paint a clear be deductible under Section 33(1) Working-out-Corporate-Income-Taxes/ picture of the intention of the of the ITA provided that they are Speci!c-topics/Income-Tax-Treatment-of- taxpayer. not specifically disallowed under Virtual-Currencies/. (6) Circumstances responsible for Section 39 of the ITA. However, it 14 #e Malaysia Reserve, No ban on sale is difficult to draw the line between cryptocurrency tradings, says Johari, on 2 The principle here is that if capital versus revenue in an actual March 2018, https://themalaysianreserve. the sale of cryptocurrency situation where a person may com/2018/01/02/no-ban-cryptocurrency- is occasioned by a sudden initially purchase cryptocurrency tradings-says-johari/. emergency or unanticipated need for investment purposes but 15 Bank Negara Malaysia, Anti-Money for funds, such facts will tend to subsequently uses it to settle debts. Laundering and Counter Financing of indicate that the cryptocurrency The question that arises would be, Terrorism (AML/CFT) – Digital Currencies was not acquired for the purpose is this still a capital transaction? If (Sector 6), on 2 March 2018, http://www. of resale at a profit and that the not, which value to be used for tax bnm.gov.my/index.php?ch=57&pg=538&ac sale was not pursuant to a profit purposes? =680&bb=!le. making undertaking or scheme. For speculators, they might even 16 #e Star Online, IRB: Cryptocurrency not This principle involves a be able to claim their interests costs regulated but traders are still subject to subjective study into the paid to hold the cryptocurrency. Malaysian income tax law, on 2 March surrounding circumstances On the other hand, for Bitcoin 2018, relating to the sale of miners, expenses such as electricity https://www.thestar.com.my/tech/tech- cryptocurrency and will be and salary may be eligible for tax news/2018/01/19/irb-cryptocurrency- determined according to the deductions and the Bitcoin mining not-regulated-but-traders-still-subject-to- merits of each individual case. computers may be eligible for capital malaysian-income-tax/. Based on the analysis of badges of allowances pursuant to Schedule 3 of 17 Paragraph 28 Schedule 6 of the Income Tax trade above, the cryptocurrency the ITA. Act 1967. speculators may be considered as 18 Starbizweek, Bitcoin: Utter pipedream, on engaging in an adventure in the SO WHAT’S NEXT? 10 February 2018, https://www.thestar.com. nature of a trade and their gains #e IRBM has $red the $rst salvo my/business/business-news/2018/02/10/ will be taxable. in opening an investigation into bitcoin-utter-pipedream/. Luno, it remains to be seen whether Chong Mun Yew is an Executive IS THERE AN UPSIDE? their enforcement actions would be Director, Crowe Horwath KL Tax Sdn On the bright side, if the limited to cryptocurrency exchanges Bhd. He can be contacted at munyew. taxpayer is held to be engaging in an or will it be expanded to the numerous [email protected]. #e adventure in the nature of a trade, merchants that have started accepting views expressed here are the writer’s all expenses wholly and exclusively cryptocurrencies in their businesses. personal views. incurred in earning that income will How to tax a decentralised

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